#5 & #6 Directors' Duties

Question 1

Directors’ duties are owed to…

Answer 1

the company (s170(1) CA 2006) and not shareholders individually or collectively or any other body or person (e.g. creditors and those mentioned in s172(1)(a)-(f))

Question 2

Sharp v Blank

Answer 2

fiduciary relationship between directors and shareholders requires something “over and above the usual relationship” – “some personal relationship or particular dealing or transaction between them”

Question 3

Coleman v Myers

Answer 3

fiduciary relationship between directors and shareholders: family business + traditionally relied on the directors for advice

Question 4

s171

Answer 4

duty to act with powers and for ‘proper purpose’

Question 5

s171(b): test of proper purpose

Answer 5

objective

2-stage

• (i) the range of legally permissible purposes will be established;
• (ii) the actual exercise of power will be analysed against the range of legally permissible purposes

Question 6

Howard Smith v Ampol

Answer 6

Improper purpose under s171(b)

Facts: directors allotted new shares to dilute the existing shareholding of the majority shareholders to favour their proposed take-over bidder

Held that it was for an improper purpose, absence of self-interest does not make the issue valid

Question 7

Extrasure Travel Insurance v Scattergood

Answer 7

Improper purpose under s171(b)

transfer of funds in the company to meet the demands of a particular creditor of a company is an improper purpose

Question 8

Criterion Properties

Answer 8

Improper purpose under s171(b)

‘poison pill agreement’ (to make the company an unattractive target by making it onerous to dismissing the existing board) was an improper purpose

Question 9

Mills v Mills

Answer 9

Improper purpose under s171(b)

issue of bonus shares which strengthened voting power of the ordinary shareholders and diminished the rights of the preference shareholders to shares in assets in a winding up – held that the directors acted honestly in what they believed to be the best interests of the company, and the fact that a director stood to gain from their decision did not invalidate it

Question 10

Eclars Group v JKX

Answer 10

Test for mixed motive in s171(b)

the test being causation (‘but for’) (favored by Lord Sumption), instead of the traditional ‘principal/primary purpose’ test (favored by Lord Mance)

In this case, improper purpose since the restriction of exercise of voting was to prevent voting on shareholder resolutions instead of disclosure of information

Question 11

s172

Answer 11

Duty to promote the success of the company

NOTE: good faith + take into account of non-shareholder interests

Subjective test

Question 12

Test of good faith s172

Answer 12

Subjective test
- Regentcrest plc v Cohen: since the directors genuinely believed that the waiver was in the best interest of the company, it was legitimate

Where directors gave no consideration at all to the question of the company’s interests, the proper test is objective – whether an intelligent and honest man in the position of a director of the company concerned could, in the circumstances, have reasonably believed that the transaction was for the benefit of the company (Re HLC Environmental Projects Ltd)

Question 13

Interests of the company under common law s172

Answer 13

Shareholder Primacy

Interests of the company, as an artificial person, cannot be distinguished from the interests of the persons who are interested in it (Brady v Brady)

The interests of the company were generally equated with the interests of the shareholders – NOTE that it’s not necessarily just the current shareholders (Gaiman)

Question 14

Enlightened Shareholder Value Approach under s172

Answer 14

currently the value underlying s172

the interests of a company are best served by generating maximum shareholder-value, but, in order to do so over the long-term, non-shareholder stakeholder interests should be considered

i.e. primarily still shareholders, but if there are alternative ways of doing it, then take into account of non-shareholders

Question 15

Reasons of doubting actual change under enlightened shareholder value approach s172

Answer 15

Non-shareholder stakeholders (save for creditors) do not have rights of enforcement for breach of duty – only shareholders can commence derivative claims on behalf of the company, and remedies flow to the company itself (hence no incentive)

Well-advised boards will paper evidence compliance in board minutes

There is already consideration of the long-term impacts on members under the common law – i.e. the consideration has already been made, you only need to make it obvious now

If the interests of the company as a separate entity are in conflict with the interests of the members as a whole, or at least some of them, it would appear that the interests of the company should be preferred (Mutual Life Assurance Co of New York v Rank Orgaization Ltd – a common law case)

The considerations in s172(1) will allow directors to justify almost any bona fide approach to delivering the success of the company

Question 16

Extrasure Travel Insurances Ltd v Scattergood

Answer 16

Facts: subsidiary company paid a level of cash to its parent company, since the parent had a loan that was pressing. It was argued that this arrangement was to help the parent and not for the subsidiary – but the parent argued that its survival is key to the subsidiary

Held: an objective director would not have thought about the cash was key to the survival of the parent which was key to the subsidiary – this suggests that the directors did not subjectively think about it

NOTE: showing how objective can be used for subjective

Question 17

Three Obligations under s172

Answer 17

Ancillary Obligation to Disclose Wrongdoing

Corporate Reporting Requirement

Creditors

Question 18

Ancillary Obligation to Disclose Wrongdoing s172

Answer 18

Item Software (UK) Ltd v Fassihi: if a director breaches his duty to the company, the director is also required to disclose the wrongdoing to the company (if disclosure is required by the general equitable duty to act bona fide in what the director considers to be the interests of the company)

Jack J in Chadwick: unnecessary

Applies to disclosure of information other than misconduct (GHLM Trading Ltd v Maroo)

Practical significance
 Efficiency – not to waste resources in discovering the wrongdoing (Fassihi)
 Statute of limitation (Ackerman)

Question 19

Corporate Reporting Requirement s172

Answer 19

“Large companies” are required to provide a formal s172 compliance statement in their annual Strategic Report (s414CZA CA 2006) – explaining how the company’s directors have had regard to the matters set-out in ss172(1)(a) to (f) when performing their duties under s172

UK Corporate Governance Code (UK CG Code) recommends, on a “comply-or-explain” basis, that premium-listed companies disclose how the matters set out in s172 have been considered in board discussions and decision-making (Provision 5 UK CG Code)

Question 20

Creditors s172 - directors’ common law duty

Answer 20

Directors’ common law duty to avoid prejudicing the interests of creditors when company is insolvent (Brady v Brady)/doubtful solvency (Nicholson v Permakraft (NZ) Ltd)

Where a company is insolvent, the interests of the creditors intrude (i.e. priority) (Kinsela v Russell Kinsela Pty) – prospective entitlement of creditors displacing the power of the shareholders and directors to deal with company’s assets

Re HLC Environmental Projects Ltd: a director who prefers one creditor to another may be in breach of the duty to act in the interests of the creditors as a whole

BTI 2014 v Sequana: only applies where there’s real risk of insolvency – to progressively think about creditors’ interests – a progressive balancing act between creditor and shareholder interests as the company becomes more insolvent

Question 21

Creditors s172 - fraudulent trading (s213 IA)

Answer 21

On the winding up of a company, where it appears that any business of the company has been carried on with intent to defraud creditors, or for any fraudulent purpose, the court may declare any person who was knowingly involved in the fraud to make such contribution to the company’s assets as the court thinks fit

Re Patrick Lyon Ltd: directors delayed winding up the company since they wanted their debentures to mature to ensure that they get the priority – fraudulent trading

Question 22

Creditors s172 - wrongful trading (s214 IA)

Answer 22

On the winding-up of an insolvent company, the court may declare a company director liable to make such contribution to the company’s assets as the court thinks fit if, some time before the commencement of the winding-up of the company, he knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation, unless the court is satisfied that thereafter he took every step with a view to minimising the potential loss to creditors he ought to have taken

Subjective-Objective Basis: what a director ought to have known or have concluded or done depends on…
• (a) (objective) what a reasonable director carrying out similar functions in that type of company would know, conclude or do; and
• (b) (subjective) the general knowledge, skill and experience of that director

Difficulty in assessing whether there’s “no reasonable prospect”
• Re Continental Assurance Co of London plc: not liable where there’s consideration of the prospect, including taking in legal advice
• Rubin v Gunner: not liable where directors thought there was rescue financing

Question 23

s173

Answer 23

duty to exercise independent judgment

Question 24

s173: duty to exercise independent judgment

Answer 24

Not infringed by…
s173(2)(a): acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors (Fulham Football Club)
s173(2)(b): in a way authorised by the company’s constitution

Question 25

s174

Answer 25

Duty to Exercise Care, Skill and Diligence

Question 26

Test in s174

Answer 26

This is an objective-subjective test developed in Norman v Theodore Goddard

Objective: general knowledge, skill and competence reasonably expected of a person carrying out the same functions as the director (s174(a))

Subjective: general knowledge, skill and experience that the director has (s174(b))

Question 27

Re D’Jan of London

Answer 27

director negligently failed to fill in a question in the insurance form – held that by signing the form, he accepted that he was the person who should take responsibility for its contents

Question 28

Delegation of function s174

Answer 28

Re Barings Plc (No.5): need to show…
o (i) exercised care to ensure that the delegate has the competence;
o (ii) after you delegate, you have a duty to ensure that you supervise the discharge of those duties; and
o (iii) required to maintain an understanding of the company’s business

Question 29

Dorchester Finance Co v Stebbing

Answer 29

directors cannot escape liability for negligence simply by avoiding undertaking any activities in their director’s role

Question 30

Re Pro4Sport Ltd

Answer 30

judicial deference – i.e. a reasonable decision need not be the optimal one that could have been made under the circumstances, and the court will not retrospectively second-guess a director’s commercial judgement

Question 31

Depends on function of the person s174

Answer 31

Equitable Life Assurance Society v Bowley: NEDs do play a role, and you have to exercise an independent judgment and supervise the executive management team

Lexi Holdings plc (in admin) v Luqman
o Facts: company consisting of a brother and two sisters (the latter two who were just in the board in name) ended up with the brother stealing money from the company, but the sisters were ignorant
o Held: sisters have not met the minimum requirement of supervising what’s going on with the company

Question 32

reliance on others s174

Answer 32

Australian Securities and Investments Commission v Healey: directors’ obligations to keep informed, pay due attention, and ensure their board is appropriately competent – merely good faith and rely on professional advice is not enough, must consider whether the advice/financial statements were consistent with personal knowledge of the company’s financial position

Madoff Securities International v Raven: legitimate reliance on other directors whose integrity, skill and competence he has no reason to suspect

Question 33

s175

Answer 33

Duty to Avoid Conflict of Interest

Question 34

No conflicts rule formulation s175

Answer 34

Lord Carnwath’s formulation in Aberdeen Railway: no fiduciary ‘shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which may possibly conflict, with the interests of those whom he is bound to protect’

Question 35

Pyke

Answer 35

director set up his own company to contract with a company which the original company is trading with – breach of the rules – should enter into the contract for the original company instead

Question 36

“corporate opportunities” s175

Answer 36

Wide view – i.e. anything that could possibly be of interest to the company, even if pursuit is legally or practically impossible (Regal (Hastings))
- Allied Business: test of relevance

The narrower “scope of business” and “maturing business opportunity” tests are rejected in Allied Business and Financial Consultants v Shanahan

Question 37

Cook v Deeks

Answer 37

Example of exploitation of property or information

negotiating a contract on behalf of the company in own name and not for the company

Question 38

Regal (Hastings) v Gulliver

Answer 38

company was unable to fund the increase of capital of its subsidiary company as requested by the third party, directors hence decided to subscribe personally – conflict of interest, A’s inability was an immaterial factor, liability arises from the mere fact of a profit having been made

Need to establish…
• (i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilization of their opportunities and special knowledge as directors; and
• (ii) that what they did resulted in a profit to themselves

Question 39

Cooley

Answer 39

third party approached director to resurrect the project after it decided not to go forward with the original company – held conflict of interest, immaterial that the company could not take advantage of the opportunity, there’s duty to tell the company

Question 40

Bhullar v Bhullar

Answer 40

a family invested in properties when the other family indicated that the company would stop acquiring properties – held conflict, since it was within the scope and line of business, the company should have the chance to change its mind

Scope of business test

Question 41

Allied Business and Financial Consultants v Shanahan

Answer 41

directors acquired an investment property through another company which they came across in the course of the original company’s business, but the original company is a financial service company (outside of scope of business) – held conflict, it is relevant for the company to know and the director has a duty to inform, not for the director to make his own decision that the company will not be interested and to proceed to appropriate the opportunity for himself

Suggesting test of relevance – whether the opportunity is relevant, but relevance is a broad notion, basically captures everything – it’s better to be clean than leaving scope for abuse

Question 42

Towers v Premier Waste Management

Answer 42

directors given lease of equipment by a client for no charge and failed to disclose, equipment have no use to the company – held conflict, due to loyalty to the company, which embrace a duty not to make a secret profit

Question 43

s175(4)

Answer 43

Cannot reasonably be regarded as likely to give rise to a conflict of interest

Peso Silver Mines Ltd v Cropper: Canadian case – board of directors rejected a proposal to buy 126 prospecting claims near the company’s own mining territories, some directors did so in their personal capacities – held no conflict, impossible to say that the director obtained the interest by reason of the fact that he was a director of the company and in the course of the execution of that office, that he acted in good faith and was approached by the offeror in his personal capacity
 NOTE: not adopted in UK cases, and Bhullar v Bhullar seems to go against it

Question 44

Canadian Aero Service Ltd v O’Mally

Answer 44

post resignation s175

o (i) the defendants had diverted for their own benefit a ‘maturing business opportunity’ which their company was actively pursuing;
o (ii) they were participants in the negotiations on behalf of the company;
o (iii) their resignation had been ‘prompted or influenced’ by a wish to acquire the opportunity for themselves; and
o (iv) it was their position with the company rather than a ‘fresh initiative’ which led them to the opportunity which they later acquired

Question 45

Foster Bryant Surveying v Bryant, Savernake Property Consultants Ltd

Answer 45

director was forced out of the company by his business partner and co-director, opened a company few days before resignation, and was asked by a former client to do some work – held no breach, since did not resign for the corporate opportunity, no bad faith, the offer was made to him instead of him actively searching for it

Question 46

CMS Dolphin v Simonet AND Shepherds Investments Ltd v Walters (TWO SEPARATE CASES)

Answer 46

post-resignation s175

former director set up a competing business and diverted business opportunity and misused confidential information – held breach, liable to account for the profits generated for the period of ‘advance start’ that their breach had given them, but not liable for damages because no loss was proved to have been caused by the breach

Question 47

Multiple Directorship

Answer 47

Even if the second directorship is in a company that competes with the first company, issues only arise if there is an actual conflict of interest (London and Mashonaland Co Ltd v New Mashonaland Exploration Co Ltd – chair of A was also on the board of competitor B)

Where the two positions give rise to conflicting fiduciary duties, the fiduciary must have the informed consent of both principals (Clark Boyce v Mouat)

Pyke: director of marginalized in the company and he created a company to enter into a contract with the original company’s client – held no breach, the new company was not using any of the original company’s property, and due to the marginalization, the director had a nominal role in the original company anyways

Halcyon House Ltd v Baines: director set up a new company with intention to compete with previous company after resignation during negotiation of the resignation agreement – held no breach, since resignation was not to take up an opportunity, but due to a fall out

Question 48

Authorizing Conflicts of Interest

Answer 48

PRIVATE Companies (s175(5)(a)): the duty will not be infringed where the matter is proposed to and authorised by the directors, excluding any votes cast by the interested director(s) (unless the company’s constitution provides otherwise)

PUBLIC Companies (s175(5)(b)): where the company’s constitution includes provision enabling the directors to authorise the matter, the duty will not be infringed where the matter is duly proposed to and authorised by the directors

Question 49

s176

Answer 49

Duty Not to Accept Benefits from Third Parties

NOTE: there must be conflict of interest for s176 to be in breach of s176 (s176(4))

NOTE: benefit may be financial or non-financial, of any shape or size, although s176(4) ensures that trivial benefits are not caught by the provision, and s176(3) covers payment of normal salary and benefits

Most significant difference between s175 and s176: no provision for authorization by the board of directors

Question 50

Industries & General Mortgage Co Ltd v Lewis

Answer 50

agent received secret profit, being part of the commission received – held breach, if fiduciary receives secret profit, his mind would be influenced when making commercial decisions and therefore may not act in the best interests of the company

Question 51

s177

Answer 51

Disclosure in Proposed Transactions or Arrangement

Methods of disclosure (s177(2))

Exceptions (s177(6))
o Where the interest cannot reasonably be regarded as likely to give rise to a conflict of interest;
 Cowan de Groot Properties Ltd v Eagle Trust plc
o Where the other directors are already aware (or ought reasonably to be aware) of the interest; or
o Where the interest is in the director’s service contract which has been, or will be, considered by the board or a committee thereof
 Runciman v Walter Runciman plc
- ANOTHER EXCEPTION not included in the section but recognized in s186: that the director of a company with only one director is not required to make a declaration to himself, although the terms of these arrangements must be set out in writing or recorded in the minutes (s231)

Question 52

s182

Answer 52

Disclosure in Existing Transaction or Arrangement

Methods of disclosure – mandatory requirements (s182(2))

s182(6) sets out the same exceptions as in s177(6)

s182(1): this section does not apply if or to the extent that the interest has been declared under s177

Question 53

Remedies for ss177 and 182

Answer 53

a breach of s177 only elicits civil remedies (s178), whereas a breach of s182 is a criminal offence punishable by with a fine (s183)

Question 54

Authorization and Ratification of Breach

Answer 54

Apart from s175, the only way to escape liability is through shareholders

Authorization = pre-approval of the breach

Ratification = approval after the breach

Unratifiable Wrongs
- Prohibition on ratification by shareholders once creditor interests intrude
o Kinsela v Russell Kinsela Pty: once the company is insolvent, the company’s interests becomes the creditor’s, hence there’s no power to ratify
- Shareholders cannot ratify director misconduct that amounts to “fraud”
o Concept of “fraud on the minority” (Burland v Earle – where the majority misappropriates money, property or advantages that belong to the company)
- In reality, it’s about whether the wrongdoer has control over the company – in order to protect minority shareholders, to enable them to bring derivative claims

Question 55

Knowing Receipt

Answer 55

The degree of knowledge required remains unsettled
–> Bank of Credit and Commercial International (Overseas) Ltd v Chief Akindele proposes a single test of unconscionability

Remedy: account for profits

Question 56

Dishonest Assistance

Answer 56

Barlow Clowes v Eurotrust International: objective test of dishonesty

Remedy: loss of the beneficiary

Question 57

Proprietary Claim

Answer 57

Having received the company’s property without being able to assert the protection of bona fide purchaser for value without knowledge of the company’s interests - i.e. done of gifts or purchasers without bona fides